The Math and Logic Behind Apple’s Deal with Verizon

Apple has made a smart business decision about the impact of adding Verizon as a carrier, and the net result must be an expected increase in iPhone sales and an increase in market share. A few disgruntled AT&T customers who defect aren’t going to offset that.

Understanding the financial means and intentions of your customers is key to any business strategy, but listening to some people, you’d think that Apple won’t gain much market share against Android because of millions of defections from AT&T. It’s just not going to go that way, and here’s why.

Courtesy: Apple

The Numbers Game

First, dissatisfaction with the AT&T network is one of those areas where a small number of people can make a big fuss, and that catches the attention of news reporters. In fact, AT&T’s churn rate has been falling, and is just over one percent. (The churn rate is the percentage of customers over a period of time who cancel their service and move to another carrier.) If AT&T’s customers were as universally angry as on might be led to believe, then the churn rate would be a lot higher. People know that AT&T is working to improve their network, and they love their iPhones.

Next, current AT&T customers have a sober decision to make when it come to defecting to Verizon. Do those current customers really want to move to a Verizon iPhone that can’t do concurrent data and voice, can’t be used overseas, and which, in principle is slower? (AT&T uses HSPA 3G which is faster than Verizon’s EV-DO network.) A little reading of the tech news and a review of their AT&T contract will give them pause. It’ll cost US$325 to break their AT&T contract, for starters, pro-rated down US$10/month. My take is that not many, percentage-wise, will pay that price just to jump to Verizon. If they were that unhappy, they would have already switched — if they could.

On the other hand, there are lots of reasons for Verizon customers to dump Android or perhaps their older feature phone contracts to get an iPhone. The drool-factor of the iPhone hasn’t gone away, and Verizon is well aware of the pent up demand for the iPhone based on feedback from customers. Another good reason to have a Verizon iPhone is that it has the same OS as their iPad, an item also available from Verizon. That’s not something to be overlooked. Breaking the current Verizon contract to get an iPhone for the first time, with breathless anticipation, is a lot more compelling than breaking an AT&T contract to move from an iPhone 4 to, well, an iPhone 4. And an inferior one, in some respects, at that.

This doesn’t ignore the fact that Verizon wants to steal customers from AT&T, and they’ll try to make it worthwhile. But the churn rate doesn’t have to change much, a percentage point or so at most, to become a sweet deal for Verizon. We’re talking a million customers here — compared to the ten million plus iPhones Verizon customers are expected to buy this year.

The net-net is that only a small percentage of AT&T’s iPhone customers will defect to Verizon while a much larger percentage of Verizon’s customers will move to an iPhone. If that weren’t the case, the whole Verizon adventure by Apple would be pointless.

If we need any further evidence, it comes from an Apple executive. During Apple’s Q2 earnings report on Apri 20, 2010, Tim Cook commented on adding foreign carriers, and I reported on his observation: “In every case, in foreign countries, where Apple changed from exclusive agreements with carriers to non-exclusive agreements, market share went up. The only remaining exclusive agreements with carriers are the U.S., Germany and Spain.”

There’s no particular reason why that shouldn’t happen in the U.S., and the result will be that Apple gains considerably from the Verizon deal with more total smartphones sold and larger market share. And because the arrangement with Verizon is reported to be non-exclusive, I expect, after a suitable period of time, Apple will pour it on with T-Mobile and/or Sprint.

Sorry John, Android market share will increase with the next quarterly numbers for February and May. Any Apple gains will be at RIM’s expense. There are more fundamental things at play, like choice and continual evolution, where Apple’s iPhone has no strength.

For one thing, you can bet that all those Android phones in the Verizon store will have big old Adobe Flash logos on their signs. It was mostly a theoretical issue in 2010, but it about to get all too real.

The Flash Logo would make me go running to the iPhone. Just saying. Also, both Verizon and Apple commented that both companies receive an enormous amount of feedback from Verizon cusomters who want to switch to an iPhone. I doubt they are making that up.

Further, many Verizon users are probably uses of Apple’s other products. Some people want to stay in the same ecosystem. I use a Mac, it is just easier to go with an iPhone, iPad, etc. even if there were similar devices from other providers that might be slightly better in some regards.

Android might gain users, but I doubt many of the users will come at the expense of Apple.

Bosco - If I understand you correctly, you are saying that Android will grow more rapidly because they enable the user to have access to Adobe Flash, whereas Apple?s growth will be slower because they do not allow this. In following your discussions in the past, you base this on two factors - that users want to go to websites using flash and that developers want to build applications using flash.

While I think both points are potentially valid, the market so far disagrees with you. This could change, but only time will tell. Frankly speaking, if Flash truly becomes a killer app on Android, I would expect to see Apple accommodate it or find a better way to counter it.

No, rabber, I am saying Flash will be a factor, and an easy slash irresistible factor for Apple’s competitors in the Verizon store to use to distinguish their phones.

As to your assertions about “the market”. 3+ million Flash developers who can easily package their content for iPhone right now, and who will easily be packaging it for Android and PlayBook disagree.

Flash is about to become the default mobile API because of the number of developers and the cross-platform reach it has. Simple economics. Apple does not offer a full Flash/AIR experience. Apple also has credibility issues around Flash because of Jobs’ stupid tantrum last year.

Killer app? No. Key technology where full adoption will be imperative? Yes.

How the heck do you actually USE simultaneous voice and data with any comfort at all? I wonder how many people actually do that. I assume you don’t hold the phone away from your head a little and peer down at it while trying to type in a web location or launch an app…..so instead you put it down on the table and put it on speaker phone I guess, but that hardly seems like a compelling way to use the web most of the time and the voice quality necessarily suffers on speaker phone. When the need appears, it seems just about as easy to say on the phone, call you back, then get the web information and, you know, call ‘er back. Quaint, I know…..

There have been a few times when I was a little frustrated not being able to access Flash website. However, from what I see more and more websites are getting away from Flash, at least if they also have mobile optimized pages. Verizon comes to mind, a few months when I visited there from my iMac it was Flash heavy, but their mobile version didn’t have any. I just took a look and from what I see, well I didn’t see any Flash.

pdwatson2: I have done that many times. While talking, you press the home button and select another app, say Safari. You can, for example, check out a map to provide the caller with directions. Or look up a calendar appt. There’s a green bar along the top that says something like “Press here to return to the call.” Your voice connection never went away, and then you return to your conversation.

Indeed, you do take the phone away from your ear while you use another app for a few seconds. But if you’re using a headset/earbuds, you can *still* carry on the conversation while using another app. The green bar merely takes you back to the phone app—so you can, for example, use the keypad, etc.

Flash is no longer an issue… It doesn’t run well on mobile devices, it kills battery life and really is more for desktop use.

The majority of “popular” websites have worked around Flash on mobile devices. So unless Adobe can talk the owners of those sites to exclusively recreate them using only Flash, I doubt Flash will become the killer feature for mobile devices.

Now does that mean Flash is dead? No, but it won’t become as popular on mobile devices as it did on desktop computers.

I agree with the article that AT&T will lose a few customers but most will stay. But Apple should gain market share now that they offer the iPhone to another carrier. If it’s from the expense of RIM than Android, so be it. No one can deny that the iOS is wildly popular even if the many versions of Android has more users.

More carriers means more iPhones. More $$$ for Apple and hopefully for we small investors. Apple haters hate it, but the iPhone has compelling cachet.

The notion of being in one “eco-system” is also appealing. iMac,Macbook,iPad and iPhone… all under the same roof. I have been an Apple “fanboy” since the Apple II. Its great being part of the cult…uh, I mean club !!!

Brad, I usually find your arguments here cogent, but you’re way off base on H.264. It is THE codec in the world of video right now. Anyone doing anything meaningful with video, legit or not—from content producers to pirates ripping their blu-rays—is encoding H.264 in an MP4, MOV, or MKV wrapper. Even current LED TVs are built with the playback capability for it; plug in an external HDD and enjoy the show. Flash might be a hot issue for mobile video, but everywhere else, the multi-format video codec environment of the previous decade is over, and H.264 is the unqualified winner.

As for what market share the iPhone will take away on Verizon, the answer is very likely “any other smartphone.” Mine is just one VZ household, but my BB Curve and the wife’s Droid Incredible are both going to become iPhones as soon as practicable. For others, we’ll see what happens.

I actually block Flash on my computer and only invoke it when necessary, which for me isn’t all that often. Based strictly on functionality, I honestly don’t think most people would ever know the difference between an interface built in Flash or coded using other tools. I still say that one is going to come down to the question of resource usage, we’ll have to wait and see.

But I actually wanted to say that I’m another one that has very good experiences with AT&T. For whatever reason (perhaps because it’s a small city) their service has been great in my area. They just got around to rolling out 3G here late last year, and so far, so good.

The iPhone on Verizon may get significant customers from defecting AT&T customers or it may not, but the real source of market share for Apple and Verizon is, as John says, supra, from Verizon’s own customers but even more from all of those customers who are new to smartphones. Today, only about 25-26% of American have smartphones. That percentage is expected to be 50% no later than 2015, and it is that additional 25% that is the real prize. And by being on both AT&T and Verizon and by making the best mobile devices on the planet in its iOS devices, Apple is in the best position to capture the lion’s share of those new customers.

While I think that John is right in stating that many of Verizon’s own customers, both those with feature phones and those with Android phones, will switch to Verizon’s iPhone, along with that boost to Apple’s market share, Apple and Verizon will both see share gains from customers who are new to smartphones. For Apple, its share gains will be greatest because it will get customers whether they choose a CDMA or GSM network, because Apple competes only against other smartphones and now no longer competes against a network. Verizon will gain share because it now has the iPhone, so that it competes only against AT&T’s network and not against the iPhone.

Thus, both Verizon and Apple get to compete on the vector that each prefers: Apple will be competing purely against other smartphones, which is a competition that it believes it can win at least in the high-end of that market, while Verizon will be competing against AT&T’s network, which is a competition that it says that it can win. Apple is fairly certain to gain share because of the popularity of its iPhone against all other smartphones. Verizon at least will not lose share because of AT&T’s exclusive on the iPhone and will gain share if it can win the competition with AT&T’s network.

“How the heck do you actually USE simultaneous voice and data with any comfort at all?? I wonder how many people actually do that.? I assume you don?t hold the phone away from your head a little and peer down at it while trying to type in a web location or launch an app?..so instead you put it down on the table and put it on speaker phone I guess…”

Whoever (like me) uses a headset (bluetooth or corded) has no problem talking & googling/wikipediing/weatherbugging/web-banking/amazoning/ebaying/texting, etc. as needed. How often do I actually do that? Maybe 1-4 times a week.

Bosco
You keep saying market share is more important than profits, but that is not bourne out by history.
Profits are important if you wish to keep a company going. Profitability is what is used to leverage ones position for future innovation.

Without profit it doesn’t matter how big your market share is. Eventually you will get outflanked by the next round of technology.

It is nice to have Androids as a choice and they will make up a big part of the market, but you seem to think that that will equate with market domination.

Android’s platform is not as open fancy free as you would think. Vendors still needs to have their Android OS packaged from one source. So that ends up being pretty similar to depending upon Apple for an update. Apple has tighter control of the apps that can go on the iPhone, but that also results in less potential for security problems such as the Chinese harvesting your personal account information.

This is why long term market share matters more than short term profit share.

This is different than saying that vanilla market share is more important than vanilla profit share. What sustained sizable market share does for your product, especially in the tech space, is entrench network effects that make it difficult for competitors to displace your product.

Also, I think you mis-understand some of the dynamics of the Android market. Many people run perfectly legal mod’d ROMs, such as those from Cyanogen. Not a significant percentage of users, mind you, but some big numbers—7 figures easily. The effect of that is to keep the handset manufacturers in check and hold them accountable for updates. Tim Bray recently weighed in on Google’s position on getting root access to an Android device. Could you ever imagine anyone from Apple feeling the same way about iPhone or iPad?

But there is no such thing as long term market share where tech is concerned. And Apple has show an propensity for Long term profitability which has far outlasted any tech toy on the market. They make the market and they move the market. And they have the money to dictate what the future markets will be. At some point Apple will assemble or buy up a product which will make all of the current phones obsolete. The has been the history for nearly a decade which is fairly long in the tech world and it shows no signs of abating over the next 5 or so years.

Mod’d roms are great for those who enjoy employing their time doing such things. They are not viable for the vast majority of users who don’t like things breaking constantly.

Apple has never been a fan of jailbroken anything, but it still happens and the community doing such things probably numbers in the 7 figures as well.

But just as jailbraking iPhones will never do much as far as changing Apples production cycle. Rooted Androids will not really alter Android OS production cycle.

Both OS producers keep an eye out for things from these communities that work and incorporate things that are most useful.

This is why long term market share matters more than short term profit share.

This is different than saying that vanilla market share is more important than vanilla profit share. What sustained sizable market share does for your product, especially in the tech space, is entrench network effects that make it difficult for competitors to displace your product.

Perhaps.

The assumption that profit share is short-term is where you go wrong. What sustained sizable market share doesn’t do is prevent your competitor from consistently making a shit-ton of money with a rather small percentage of the market share by making a higher quality product that sells at high margins and leveraging the resulting outsized profit share to become the world’s most valued tech company.